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Companies often create subsidiaries when they acquire another company or when they build out a business line related but not essential to the business. A subsidiary is wholly or majority owned by the company claiming it as a subsidiary. Subsidiaries are separate companies and, therefore, the accounting rules that govern them treat them as separate but also as part of an aggregate whole.

Subsidiary Defined

A subsidiary is a division, business component or business line that is separate from the parent company. The parent company owns the majority, or 50.1 percent or more, of the equity -- stock, membership interest, or other ownership stake -- in the company. For example, your interior construction company may own 100 percent of a separate handyman services company. Your interior construction company is the parent company, and the handyman services company is the subsidiary.

Stand-alone Accounting for Subsidiaries

Since a subsidiary is a separate company, you must maintain separate accounting records for it. Your subsidiary must have its own bank accounts, financial statements, assets and liabilities. You must accurately track any personnel and expenses split between the parent and subsidiary. For example, if you operate a catering company as a subsidiary to your restaurant, you may use your chef and kitchen workers to prepare the food. You may also use the restaurant’s kitchen. You would need to allocate the applicable percentage of salaries, utilities, rent and other shared expenses to the subsidiary.

Subsidiary -– Separate Books

Your parent company and your subsidiary maintain separate sets of books. These financial statements will often include sales made to the subsidiary or purchases by the subsidiary from the parent. In addition, your parent company may make a loan to the subsidiary, or the subsidiary may transfer assets to the parent. The separate financial statements capture all of these transactions.

Consolidated Financial Statements

To present an aggregate picture of the overall company as though it were one entity, you must prepare consolidated financial statements. To do this, you combine your parent company's financials with that of the subsidiary in one set of financial statements. When you combine the two sets of accounting records, you must eliminate any and all overlaps -- all the intercompany transfers, payments and loans. You do this because a company cannot sell to itself or make loans to itself. Keeping the overlapping transactions would result in double counting and a significant distortion of the financials.

Consolidation Process

To consolidate your parent and subsidiary, use one worksheet for the balance sheet and one for the income statement to remove any intercompany loans, transfers and sales. Next, add the balance sheets and subtract the adjustment; add the income statements and subtract the adjustments. The final results are the consolidated financial statements.

About the Author

Tiffany C. Wright has been writing since 2007. She is a business owner, interim CEO and author of "Solving the Capital Equation: Financing Solutions for Small Businesses." Wright has helped companies obtain more than $31 million in financing. She holds a master's degree in finance and entrepreneurial management from the Wharton School of the University of Pennsylvania.